Loeb Effect? Japan Buybacks Hit Record In May

The companies in Japan significantly increased their capital returns to shareholders along with low valuations and steady growth in earnings per shares, according to equity strategists at Barclays.

In a note to investors, Ian Scott, an equity strategist at Barclays and his team noted that the stock buyback in Japan reached a record level, and the dividend distribution increased above expectations in May.

Japan stock buyback nearly 1 trillion yen last month

According to Scott and his team, Japanese companies announced nearly 1 trillion stock buyback last month, which appeared to be the peak month for such announcements.

The equity strategists also observed that the latest monthly increase came after a few months of weak stock buybacks. They estimated that the trailing annual figure of stock buyback in Japan remained at around 400 billion yen per month.

Scott and his team suggested that the “May surge could signal a sustained move towards higher buybacks” if the companies in Japan move up their shares repurchase program to around 1.5% of market capitalization annually.

When it comes to dividend distributions in Japan, Scott and his team observed that it seemed that Japanese companies exceeded the consensus estimates set for the fiscal year ended March 31 by around 4.5%. According to them, the dividend estimates for the FY March 2016 increased by less than 3%.

Japan companies’ payout ratio

“These upgrades are rather more evolution than revolution, but are certainly a step in the right direction,” wrote Scott and his team. According to them, the combined dividend and buyback yield in Japan in the next fiscal year would be 3.4%

Scott and his team said the yield is “well below the US equivalent of close to 5%.” However, they emphasized that companies in the United States are currently paying out more than 100% of their earnings in the form of dividend and buybacks. The payout ratio of Japanese companies is just 50%, which is measured on the same basis.

“The huge cyclicality of Japanese earnings has justified lower payouts during profit upswings in the past, and so the biggest question going forward is the sustainability of earnings. If this traditional earnings cyclicality can be damped going forward, then further improvements in the payout ratio are clearly possible.”

Scott and his team estimated that companies in Japan would achieve a 15% EPS growth for the fiscal year March 2016.

Japanese non-financial companies have been deleveraging aggressively

According to the equity strategists, the non-financial companies in Japan haven deleveraging aggressively. The improved profitability and disciplined approach to capital expenditures resulted in the dramatic expansion of their free cash flow.

Scott and his team noted that companies in Japan have been deleveraging since late 1990s, and the trend continued further last year with a net debt/equity ratio declining to 0.4. The trend is a departure from the trend in the United States.

Scott and his team said companies in Japan managed to strengthen their balance sheets and increase payouts to shareholders.The equity strategists said, “This corporate saving is not just an issue relevant to shareholders, it is also having a wider influence on the Japanese economy. The simulative effects of Abenomics are effectively being short-circuited by the heightened thrift of the corporate sector.”

Scott and his team said non-financial companies in Japan are saving at an annual rate of 7.4% of GDP. They emphasized that the defensiveness of the companies might be justified if the next economic collapse is just around the corner, and earnings and cash flows are about to crash.

However, the equity strategist emphasized that the corporate sector in Japan may cause the next downturn themselves because of “such large proportion of GDP” currently being saved.

Scott and his team said, “valuations look priced for a cyclical downturn in Japan. The market trades on a larger-than-normal discount to the US on most metrics, with EV/EBITDA having been the best guide in the past. The current 30% EV/EBITDA discount has been followed by outperformance in the past.”

Scott and his team continue to recommend an “Overweight” rating on Japanese equities within their global recommended portfolio.

Japan corporate governance

Dan Loeb Third Point recently asked Fanuc, a manufacturer of robots in Japan to implement a large buyback and fix its blatant capital inefficiency. He urged the company get on board with the changes implemented by Prime Minister Shinzo Abe as Japan moves forward with corporate governance.

Last March, Fanuc indicated its intention to boost its dividend and stock buyback in response to Third Point’s demand.

In its letter to investors in the first quarter, Loeb said his firm is finding opportunities in U.S. and Japanese equities, sovereign debt and structured credit.

Daisuke Nomoto of Columbia Management believed that corporate governance is the next catalyst for Japanese equities. According to him Prime Minister Abe’s “three arrows” represent an opportunity to lift Japan from the economic malaise that impacted the country for more than two decades.